Here's a great way to buff up California's reputation as a place to do business: Have the state, quite out of the blue, hit local entrepreneurs with four years of back taxes.

In late December, for what it called legal reasons, the Franchise Tax Board said it was not only eliminating a 20-year-old capital gains tax break provision, but it would be dunning up to 2,500 business owners and investors for tax payments, plus interest, going back to 2008.

In other words, not only are most of these investors and entrepreneurs faced with increased state income and sales taxes - not to mention the federal bump for those making more than $400,000 a year - they're going to have to cough up as much as five years' worth of capital gains taxes (current rate 9.3 percent) for which they had long been told they were not liable.

It could have been more had the statute of limitations not limited the duration of the smash and grab.

"No one knew this was coming. I didn't see it until the day before the Christmas holidays when the Franchise Tax Board sent out the notice," said Brian Overstreet, who sold his 40-person San Diego market research company, Sagient Research, last year.

Overstreet is among those entrepreneurs who initially benefited from the state's qualified small-business tax exclusion but who are now facing large tax bills for the state to recoup $120 million in back taxes.

The tax board estimates the average back-tax bill to be $60,000, but Overstreet says he believes that estimate is low. His bill is "significantly higher," and of the 30 to 40 investors and business owners he said he has heard from, the bills range from $80,000 to $500,000 (excluding interest and possible penalties).

"It's not pretty," said Overstreet, who now heads a drug safety monitoring startup, AdverseEvents, in Healdsburg.

The small-business tax exclusion, passed in 1999 and intended to spur investment in California startups and small businesses, allowed for the exclusion of 50 percent of capital gains earned from investments in businesses valued less than $50 million that have 80 percent of their staff and assets in California.

The federal government offers a similar incentive.

It appeared to be working well until a state Court of Appeal found parts of California's law - the part dealing with the restrictions to California businesses - to be unconstitutional last year. Rather than simply fixing the language or making the exclusion broader, the Franchise Tax Board invalidated the law retroactively to 2008. The statute of limitations prevented it from going back further.

"In treating all taxpayers the same - because the statute is now null and void - we are issuing tax assessments for the open years saying you can't have this exclusion," a board spokeswoman has been quoted as saying.

That sounded exceedingly lame to those who were first alerted to the change by a commentary Overstreet wrote for the online tech journal Xconomy in January.

For the Franchise Tax Board "to come out four or five years later and say, 'You followed the law, but it was unconstitutional, and now we are going to hit you with back taxes and interest,' that is just not fair tax policy," said Gina Rodriquez, a vice president at the California Taxpayers Association.

It's particularly ill timed. "The cumulative impact is chilling," Robert Ackerman, managing director of San Francisco's Allegis Capital, told Xconomy. "I have had conversations with a number of entrepreneurs as well as a number of venture firms who have indicated that they are seriously rethinking where they invest and where they build companies."

Condemning the action as "deeply unreasonable" and "immensely unfair," state Sen. Ted Lieu, D-Torrance (Los Angeles County), demanded in a Jan. 28 letter to the board that the decision to collect taxes retroactively be reversed.

On Friday, Assemblyman Bob Wieckowski, D-Fremont, weighed in, saying the tax board "sends the wrong message to the early investors and entrepreneurs who built companies and hired workers here in California." Working with the Bay Area Council, Wieckowski said he will craft a legislative fix for the "draconian" measure.

"The exclusion is one of the few tax policy tools the state has had to incentivize small business founders and investors," said the council, which is setting up Gov. Jerry Brown's April trip to China.

"The Qualified Small Business tax benefit provided a real boost to entrepreneurs and it is unfortunate that the court ruled it unconstitutional," said a spokesman for the governor's Office of Business and Economic Development, or Go-Biz, which seeks to attract and retain investment and businesses in California. "We are reviewing the situation to determine how best to help these business owners given the court's decision."

Overstreet said: "This is not just me and my issue. It has wide implications. These are people that generate hundreds of thousands of jobs and start hundreds of new companies in California. But now we can't even have certainty about how the tax landscape is going to look?